GCM Grosvenor Inc. Q1 FY2022 Earnings Call

Good day, and welcome to the GCM Grosvenor 2022 First Quarter Results Call. Later, we will conduct a question-and-answer session. As a reminder, this call will be recorded I would now like to hand the call over to Stacie Selinger, Head of Investor Relations. You may begin.

Thank you. Good morning, and welcome to GCM Grosvenor’s First Quarter 2022 Earnings Call. Today, I am joined by GCM Grosvenor’s Chairman and Chief Executive Officer, Michael Sacks; President, Jon Levin; and Chief Financial Officer, Pam Bentley. Before we discuss this quarter's results, a reminder that all statements made on this call that do not relate to matters of historical facts should be considered forward-looking statements. This includes statements regarding our current expectations for the business, our financial performance and projections. These statements are neither promises nor guarantees. They involve known and unknown risks, uncertainties and other important factors that may cause our actual results to differ materially from those indicated by the forward-looking statements on this call. Please refer to the factors in the Risk Factors section of our 10-K, our other filings with the Securities and Exchange Commission and our Earnings Release, all of which are on the Public Shareholders section of our website. We'll also refer to non-GAAP measures that we view as important in assessing the performance of our business. A reconciliation of non-GAAP metrics to the nearest GAAP metric can be found in our earnings presentation and earnings supplement, both of which are available on the Public Shareholders section of our website. Our goal is to continually improve how we communicate with and engage with our shareholders. And in that spirit, we look forward to your feedback. Thank you again for joining us. And with that, I'll turn the call over to Michael.

Thank you, Stacie. From the perspective of business performance, the first quarter of '22 was a good one regarding fundraising, revenue growth and profitability. During the quarter, we grew fee-related revenue by 10%, fee-related earnings by 26%, adjusted EBITDA by 23% and adjusted net income by 26%, all compared to the first quarter of '21. Notably, our Board again increased our stock and warrant buyback program by an additional $20 million to $65 million in total. Both Jon and I will spend more time on that topic. The strength of our business performance in the first quarter was largely the result of our success in 2021, combined with current period fundraising and good expense management despite the inflationary environment. We raised $1.3 billion, of which approximately 80% was for private markets and 20% was for absolute return strategies. Fundraising was again well diversified across vertical, geography, client channel and account structure, with infrastructure again representing the largest share at 55%. Our first quarter fundraising included modest specialized fund closures that we did not anticipate at the time of our last call. As with last year, we expect to see larger capital raising totals in the back half of the year. You can see on Slide 9 from the first quarter of 2021, our firm's share of carry and net asset value grew by $234 million or 129%, and our investments also grew, increasing by $56 million or 61%. We again captured a significant share of the increase in unrealized carry, a trend we think will continue. It's important to note that consistent with industry practice for solutions providers, most of our private markets portfolios are marked on a one quarter lag. Consequently, carry at net asset value and investment values could face headwinds as we roll forward. During the quarter, our private market verticals continued to show significant growth in management fees compared to one year ago. Our fundraising pipeline remains robust, and our re-up rates remain high at around 90%. Absolute return strategies investment performance was down around 5% to 6% through April against equity markets down 13% to 20% plus. First quarter performance was disappointing, but April performance was particularly strong with portfolios generally flat to down 1% against the down nine S&P500. The first four months of the year have exhibited strong capital preservation in tough markets. Over reasonable time periods, our returns remain competitive with peers and consistent with client objectives. Historically, this type of environment has provided opportunity to deploy capital and generate return, and periods like this can also see increased investor interest. Despite our confidence, ARS investment performance directly impacts absolute return strategies management fees and results in the loss of performance fees. With the extreme levels of volatility today, it's hard to project short-term ARS business or investment results, but with flat returns and some modest outflows from May through December 22, our ARS management fees this year would end up roughly in line with fees in 2021. With regard to private market strategies, people have spoken of a crowded PE fundraising landscape. We see that, but we also think the denominator effect and a general caution related to the level of volatility and geopolitical and economic uncertainty are in play and can slow down the timing of new commitments. We agree with the view that investors remain committed to the alternative strategies and their programs. Accounting for this dynamic, we believe that our '22 private markets management fees are likely to grow by 15% to 20% over '21. The combination of these factors means we now anticipate '22 Fee-Related Revenue growth of 7% to 10% over '21. At that rate of growth, we continue to anticipate fee-related earnings margin expansion from last year and believe ’22 Fee-Related Earnings will grow by 13% to 18% as compared to '21. Importantly, we continue to anticipate double-digit fee-related earnings growth rates for '23. We believe that geographic expansion, investments in the insurance and non-institutional channels as well as our ESG and impact capabilities give us the ability to similarly grow fee-related revenue and fee-related earnings beyond 2023. It’s pretty clear the economic and market environment have changed considerably since we last reported. Equity markets have been hurt badly, while volatility and interest rates are up significantly. There's a brutal war in Europe. China is still grappling with COVID lockdowns and supply chain stress, and high inflation persists. The Federal Reserve has moved and seems committed to continuing to do so. In light of those developments and the events of the first quarter, I think the most important thing you can take from this call is that we are growing, generating cash and returning cash to shareholders through dividends and stock repurchases. Our broad diversified platform is well built to perform for shareholders and investors in turbulent markets and to capitalize on opportunities arising from such environments. We believe repurchasing our shares here is an attractive use of our capital. As of Friday's close, after backing out period NAV from our total enterprise value, we trade at 10.6x last 12 months FRE with a 4.7% dividend yield. With that, I will turn it over to Jon.

Building on Michael's comments, notwithstanding the more difficult market backdrop, the big picture still represents a generally active capital formation and deployment environment. As a reminder, much of our capital raising is a function of our role running some part of an institution's alternatives program. The exact size and specific timing of those programs may ebb and flow with market conditions. But in general, those programs are vibrant and growing. One notable fundraising dynamic I'll highlight this quarter is the overall mix shift towards capital raised for secondaries, co-investments and direct investments. This quarter, such activities represented 72% of our private markets fundraising and have been more than 60% over the past few years. This compares to such strategies representing less than half of our AUM. Our platform delivers a strong value proposition to clients across these investment implementation types. Importantly, these flows are accretive to revenues and fee rates over time. As we expected, specialized funds were less meaningful contributors to fundraising this quarter, although we did close on capital for our infrastructure and secondaries funds, which were not expected to occur. We still anticipate that specialized fundraising activity and the associated run rate and catch-up revenue to be heavily weighted towards the back half of the year. Shifting to investment activity. Our central focus is delivering strong risk-adjusted returns for our clients over cycles, both on an absolute and relative basis. One of the benefits of our platform's breadth and diversification is its ability to pivot quickly and deploy capital towards the unique opportunities that emerge in a rapidly changing market. All of our investment teams, maybe most notably our strategic investments group, leverage our broad and deep platform of knowledge and relationships to deploy capital, especially in dislocated markets. Because we see so much deal flow and origination, we can be highly selective and thoughtfully curate portfolios. This strength of the firm is particularly relevant for the more opportunistic strategies I discussed earlier when talking about our fundraising, like secondaries, co-investments and direct investments. Our investment performance is a strong growth point. Our net IRR for our secondaries fund GSF 2, the predecessor to GSF 3, is 30%. Our net IRR for our co-investment fund, GCF 2, the predecessor to GCF 3, is 52%, and our net IRR for our opportunistic fund, MAC 2, the predecessor to MAC 3, is 31%. We also have numerous separate accounts focused all or in part on secondaries, co-investments and direct investments, which benefit similarly from our strong sourcing and execution engine. To close my comments, I will address capital allocation. One of the many attractive features of our business is its consistent cash generation. First and foremost, we have a stable and growing stream of cash generation from our fee-related earnings. Our quarterly dividend, which we've increased by more than 50% since we went public, is at a very comfortable level relative to fee-related earnings. And as we have discussed in the past, it has upside alongside our continued growth. Today, our dividend represents approximately 70% of our last 12-month FRE less cost of debt. And as Michael mentioned, we expect FRE to grow by approximately 13% to 18% in 2022, giving us room to grow the dividend in the future. We also generate cash from incentive fees, which are the combination of ARS performance fees, which are typically annual in private markets carry, which is typically longer dated. While more variable in nature, our earnings power from incentive fees is strong and growing. This incremental cash generation gives us flexibility to reinvest in the business, repay debt or return capital to shareholders. At any time we have an opportunity to reinvest in the business at a high rate of return, we will pursue that path to add value to our clients and shareholders. However, aside from such opportunities, we will return value to shareholders through repurchases. We generated $105 million of net incentive fees across 2020 and 2021 and have approved $65 million of share repurchases. We have repurchased 1.2 million shares and 1.2 million warrants to date, and we believe that further repurchases at these levels represent good value. We believe that this approach to capital allocation will result in largely offsetting dilution from employee stock awards and will create value and alignment with and for shareholders over time. Now I'll turn the call over to Pam.

Thanks, Jon. The first quarter of '22 was a solid one for the firm. Fee-related revenue increased by 10% over the first quarter of '21, driven by the fundraising success that we've enjoyed over the past year. Our assets under management grew 10% and fee-paying assets under management grew 8% from a year ago. Private markets continue to be the key driver of growth, with private markets keeping AUM growing 17% over the last year. Private markets management fees were $46.8 million in the quarter, an increase of 16% from the first quarter of '21, inclusive of $1 million of catch-up management fees. Importantly, adjusting for the impact of catch-up management fees in the fourth quarter, private markets management fees grew by $1 million or 2% on a sequential quarter basis, reflecting the continued strength in that business. One of the other notable aspects of our private market business is its stability; private market fee-paying assets under management comprised 58% of our fee-paying AUM and are generally not impacted by valuation changes. Additionally, the capital is long duration. As of quarter end, more than 65% of private markets AUM had a remaining program life of more than seven years. Private market fee rates have been stable over recent time periods, and we also continue to experience a mix shift towards higher fee activities, including co-investments, direct investments and secondaries. Absolute Return strategies management fees were $42.7 million in the quarter, an increase of 7% from the first quarter of '21. ARS performance in the first quarter resulted in a sequential quarter decline in ARS fee-paying AUM. Given our quarterly ARS management fees are generally charged on fee-paying AUM as of the first day of each quarter, the decline in ARS fee-paying AUM will drive a sequential decrease in second quarter ARS management fees. Incentive fees in the first quarter were $12 million, the majority of which was from realizations of carried interest. Gross carried interest was $11 million in the quarter, which was lower than recent levels as the uncertain market backdrop muted realization. Given ARS performance in the first quarter, unless there is a rebound in the market over the balance of this year, we are unlikely to realize significant additional performance fees in '22. Despite market conditions and the potential for slower near-term realizations, our long-term earnings power from incentive fee revenue is strong. Our run rate annual ARS performance fee earnings power remains at $39 million, and we have realized performance fees of more than $50 million in each of the past two years. More significantly, the firm's future carried interest earnings power is steadily increasing, with the firm's share of unrealized carried interest up 129% from a year ago to $415 million. Turning to expenses. Fee-related earnings compensation in the quarter was $40.9 million, slightly higher than the fourth quarter as we anticipated, but relatively flat compared to the first quarter of last year. We expect fee-related earnings compensation to be relatively stable in the coming quarters. Non-GAAP general and administrative and other expenses were $18 million in the quarter, slightly higher than the fourth quarter as travel activity began to partially resume relating to higher in-person client engagement. We've spoken before about the operating leverage inherent in our business, which once again drove earnings growth and margin expansion this quarter. Our Fee-Related Earnings increased 26% to $31.7 million, and our Fee-Related Earnings margin expanded from 30% to 35% compared to a year ago. We still expect to see growth in our fee-related earnings margin this year with room to expand our margins even further in 2023. Finally, we continue to enjoy consistent cash generation, as Jon discussed. We are comfortable with our current debt level and enjoy its term and duration. Notably, the majority of our outstanding debt is hedged, limiting our exposure to a rising interest rate environment. Looking across the firm, despite the broader market and geopolitical disruption, we are proud of the platform's ability to deliver a strong client value proposition and excited by the earnings power of our business. Thank you again for joining us, and we're now happy to take your questions.

And our first question will come from Ken Worthington with JPMorgan.

Some technical difficulties here. Okay. First, in terms of the absolute return business performance this quarter, Grosvenor underperformed actually almost wiping out a year’s worth return. So you mentioned that April was really good. What happened in 1Q that didn't happen in April? And I guess how are you managing your portfolio of absolute return managers given this underperformance in 1Q?

Ken, it's Michael. Thank you for the question. As we said, we were disappointed in the first quarter. The first quarter's results were driven by a small number of managers that were operating in the equity space. Those managers were managers that have contributed to outperformance over the last three years, where we've competed very well with peers and beaten the indices, and they had a tough first quarter. And when I say outperformance, that's through the first quarter. Hedge fund managers, as you know, move quickly and have the degrees of freedom in terms of their exposure, how they manage their book and their risk. They had moved pretty significantly to reduce exposure and to change orientation by the end of Q1. You saw that in April with a modest negative result in a very broad down market. And our feeling is these are the types of markets that yield good opportunity for hedge funds. It's a type of market where hedge funds can add a lot of value. You can see investor interest increase. And while we were disappointed by the first quarter, sitting at the end of April where our portfolio is set against markets down as significantly as they were, having had the volatility come out of the book in April the way it did coming into the first period of time here in May, our confidence with regard to that strategy and its ability to add value going forward remains very high.

Okay. Regarding expenses, it seems that cash compensation has decreased compared to last year. I recall you previously projected an increase in the high single-digit range, but it appears we are not on track for that at the moment. Can you share what might be causing the lack of growth? I believe it was mentioned in the prepared remarks that this is a good run rate, possibly setting up for the end of the year. Should we anticipate cash compensation to increase to achieve that high single-digit growth, or is it possible that it will remain flat?

Pam, do you want to take that?

Sure. Thanks, Ken. Yes, as I said in my remarks, we really expect the FRE comp line to be relatively stable in the coming quarters, which does imply a level that's in line with or just slightly up from the prior year actuals, that is lower than what we anticipated at the time of our fourth quarter earnings call. A portion of our compensation is variable, and we're certainly planning to manage compensation and headcount growth through the balance of the year to achieve that flat result.

And our next question will come from Jeff Schmitt with William Blair.

The average fee rate for absolute return strategies actually ticked up a little bit. I think it was 0.69% in the quarter, up from 0.6% last quarter and after sliding really for several years, could you speak to what is going on there? And is 0.69% a better run rate going forward?

Thank you. Our fees have remained stable for an extended period. As we've mentioned during the call, this applies across all our sectors, including our absolute return sector. We've seen a slight shift toward direct activities and co-investments, which positively impacts our average fee rates. Additionally, in our absolute return strategies, fees may decrease with size, so bringing in new investors at lower sizes benefits our average fee rates. Overall, our fee stability has persisted over the past several quarters, and we believe it will continue in the future.

Okay. That makes sense. How much were the catch-up management fees in the quarter? I didn't see that anymore. How much do you expect that to increase over the next few quarters? I think you're anticipating a much stronger second half.

Go ahead.

Great. As I mentioned earlier, the catch-up management fees for the quarter were approximately $1 million. Compared to the first quarter of 2021, which was 1.5%, and the fourth quarter, which was at 4.3%, normalizing our revenue growth after excluding these fees provides a clearer picture. Our private market fees increased by about 2% this quarter compared to the fourth quarter when excluding the impact of catch-up management fees. We do anticipate those fees will rise in the latter half of the year. As Jon noted, we expect increased funding for specialized funds during the second half, similar to last year, which could serve as a reliable indicator for our performance.

And our next question will come from Adam Beatty with UBS.

I wanted to ask about the potential fundraising opportunity for absolute return. Michael, I think you mentioned that in times of volatility and market disruption like this, investors often turn to capital preservation strategies. Could you share your perspective on what you've observed in the past regarding how long this tendency takes to develop and its potential scale? Additionally, what are you currently hearing from clients?

Thank you. Given the current market volatility, it's challenging to have clear visibility. However, periods of significant outperformance compared to equities can draw considerable investor interest, as we've observed in the past. We have consistently stated that our fee-paying assets under management in absolute return strategies will be influenced by performance rather than flows, and we stand by that. If the market continues to progress as it has, and hedge funds start improving their performance, we could see an uptick in investor interest. That said, it's reasonable to expect that actual returns will drive assets under management, while flows may fluctuate around modestly positive or negative levels.

Got it. That's clear. And then turning to kind of the other part of expenses and margin. You talked, Pam, I think, about G&A being driven a little bit upwards, resumed travel type activity, et cetera. Assuming kind of the COVID backdrop remains modestly positively trending, I guess, what have you baked in, in terms of increases in either travel-related G&A or other types of non-comp expenses for the year? And what might be the main sources of flex in that, if any?

Sure. Thanks for the question. I think for the balance year, we are planning to see or have built in assumptions around continued increases in travel. Obviously, that's manageable depending on the environment. And we've, of course, learned to work well in a virtual world. So certainly manageable expense, but our guidance that Michael spoke to in his remarks of 13% to 18% of our growth for the year assumes a modest increase in that G&A line through the balance of the year.

And our next question will come from Kevin Tripp with Oppenheimer & Co.

This quarter and after Mosaic, there appears to be a good contribution from realized investment income. I'm curious if this mostly comes from your investments in the underlying funds, or are there other factors at play? Additionally, should we expect this to remain somewhat inconsistent due to the timing of the underlying investments?

Yes. So thanks for the question. I think that line is always a bit lumpy in nature and due to the timing. It is mostly driven by certainly last quarter. It's mostly driven by carry as opposed to stakes like traditional carry, and it will continue to be driven by carry for the remainder of this year, and then we'll get to a place where performance fees will also be an important component of that line.

And just to add to Michael's comments, that's right, it is mostly stakes in our underlying investment funds on that line item. And as Michael mentioned, it's on the private market funds that tend to be realizations a quarter in arrears. And so that's coming from really fourth-quarter activity and a strong market backdrop.

And next will be Michael Cyprys with Morgan Stanley.

Michael, I was hoping you could expand upon some of your earlier comments around the fundraising backdrop. It sounds like what you're seeing is just more of an impact of the denominator, if I heard you right, as opposed to more of the crowding itself, the denominator effect? And is this more evident in the U.S. pension fund community? Or which part of the marketplace are you seeing this have more of an impact? And then could you also just expand upon how this is impacting your outlook, understanding you adjusted your guidance? But if you could maybe just flesh out kind of the key drivers there. Is this more of a delay to later in the year into '23? And how much of this could ultimately impact the sizing of what's raised?

Thank you, Michael, it's great to speak with you. Fundraising has not been affected so far; our first quarter results met our expectations. We even experienced some unexpected co-mingled fund flows. Our fundraising pipeline is very robust and improved compared to last year, particularly in the most likely categories we monitor. There hasn't been an impact on fundraising yet, and we believe that people remain committed to the programs and are willing to move forward. While there has been discussion about a competitive fundraising landscape, that's been common for some time now. Sponsors have been returning at an increased pace, which isn’t a new trend from the last quarter. However, what has changed is the denominator effect, which is influencing institutions globally. With declining equity markets, tight credit markets, and stable private market valuations, there is currently a greater inclination towards private markets compared to last quarter. Additionally, a significant amount of change has occurred in the environment since our last update. Thus, we think it’s wise to consider that this could lead to a slowdown, potentially delaying commitment timelines. We believe this is a trend related to 2022-2023, not a question of whether to invest or not. It’s something we see as specific to this period, and we felt it was sensible to base some of our assumptions on this. Ultimately, we will see how the growth rate of our private markets business compares to our initial projections, but it should become clear that the fundraising environment remains strong with ongoing demand, albeit with some disruptions from the past quarter.

Great. And just maybe as a follow-up, if you could maybe help flesh out which products you have in the market that you are raising here and expect to raise over the next couple of quarters? Any sort of amounts you're able to maybe help us remind us on with respect to hard cash.

Yes, sorry, go ahead.

And then I'm just going to ask just about any update on retail initiatives on the fundraising front.

Sure. Okay. So with regard to the specialized funds, we've got some information we now include in our deck in terms of the target size, what we raised in the quarter that just closed, what we're in and kind of where we have to go. We've generally had good success marching towards our goal with regard to all of our specialized funds. We still have secondaries, co-invests, infrastructure and multi-asset class in the market, and several of those multi-asset class and co-invest, for example, are relatively early in the fundraising cycles and will continue on in the next year. And so we do anticipate incremental closes throughout the year. We anticipate some second quarter closes. We are marching towards our goals there, pleased with our progress towards our goals there now. And I just wanted to note the denominator effect because it's so out there, not the sort of general response to global events and acknowledge that that could push some fundraising into '23 from '22.

And Michael, maybe I could take your second part of the question around the retail and what we're doing generally in the noninstitutional or retail space. and I think a bit of history is helpful there. So when you look at what that capital, capital from that channel represents as a percentage of our current assets under management, it's about 5%. And if you look at the flows activity over recent and even medium intermediate-term period of times, historically, it's about 10%. So obviously, it's a growing segment within our business. And really, the way the form that is taking is really representative of our business proposition generally. So we work with a number of platforms, both the large wirehouse type platforms as well as some of the regional players in terms of offering our custom account capabilities to certain parts of their advisory channels typically for some of the larger adviser teams or some of the larger clients individually. And the other thing that we do with those platforms is obviously work with our commingled funds, specialized funds that Michael was just referring to. So each of our specialized funds that we're in market with have been on at least one platform. Some of them have been on several platforms. And when you look across the number of either wirehouse or regional players, we work with almost a dozen platforms. So it's clearly an area where we continue to see activity and expect that to continue.

And our next question will come from Ken Worthington with JPMorgan.

Yes, I muted before. Regarding the buyback, the stock was down significantly this quarter but went up, so we bought back more. Additionally, you mentioned in your prepared remarks that you expect the incentive fees for ARS to be either zero or low for the year. It seems like you've restructured compensation to allow employees to be paid more from performance fees, which means they share the risks and rewards while shareholders benefit from more stable FRE. If ARS incentive fees turn out to be low or zero this year, what is the plan for employee compensation? Will employees bear that downside risk, or will it ultimately impact shareholders with an increase in cash compensation? I'm looking for clarity on your commitment to protecting shareholders.

We have taken steps to better align the interests of our team with those of shareholders and, importantly, our limited partners and investors. This alignment is beneficial. It's essential to note that when performance fees fluctuate significantly based on ARS performance, the performance fee bonus pool does as well. The senior members of our team, whose compensation is closely tied to the performance fee bonus pool, benefit in prosperous years and feel the impact more in challenging years compared to others at the firm. Most employees at the principal level and below are largely insulated from this volatility since they receive the majority of their compensation from the FRE line. Additionally, it's crucial to acknowledge that in a typical year, the performance fees, compared to the firm's share of carried interest in the incentive fee line, are split. Therefore, performance fees are not the sole component of the bonus pool. This setup provides a nice balance where employees can experience both upside potential and downside protection, maintaining alignment with shareholders and limited partners, while also enabling us to manage and sustain our FRE margins. We have previously discussed the importance of this when we look at sustainable FRE margin.

Great. And just buyback...

I think the key point is whether we can implement a programmatic buyback at your specified timeframe, remaining aligned with your annual plan. Additionally, there are times when we can be more flexible. Recently, leading up to this reporting period, we've had a programmatic buyback that hasn't been adjustable based on stock price movements. We've increased the capital allocated for buybacks, which will be utilized at some point, and we will determine the appropriate pace for those buybacks. I believe this addresses your question.

And I'm not showing any further questions at this time. Ms. Selinger. I'll now turn the conference back over to you.

Thank you. Thank you again to everyone for joining us today and for the questions. We appreciate the time and the continued engagement. Have a very nice day, and we look forward to speaking with you again next quarter.

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. We hope everyone has a great day. You may all disconnect.